Another popular type of bias is Loss Aversion Bias which can be defined as the strong will to avert losses rather than make gains. Studies have shown that people experience losses very differently from gains. People tend to experience
about twice as much pain with a loss as they experience pleasure with a gain. It is therefore concluded that psychologically, the possibility of a loss is on average twice as powerful a motivator as the possibility of making a gain of equal magnitude. As such, some traders might unknowingly fall prey to Loss Aversion Bias that would cause them to work twice as hard to avert losses but put relatively little effort into seeking profits.
Just like other biases, Loss Aversion Bias does have its own implications. One common implication of it is that it prevents people from cutting losing trades, even when they see no prospect of a turnaround. Some industry veterans have coined a diagnosis of "Get-Even-Itis" to describe this widespread affliction, whereby a Forex trader hold on too long to a falling forex in the hope that it recovers but ends up falling even further causing much larger losses. This is dangerous because the best response to a loss is to cut it fast and move on to a better trade. Another negative effect of Loss Aversion Bias is the tendency to play it too safe during trading. It can make traders dwell excessively on risk avoidance when evaluating possible gains, since dodging a loss is a more urgent concern than seeking a profit. When their Forex trades start to show a profit, loss-averse traders hasten to lock in profits, fearing that, the market might reverse itself and rescind their profits. The problem here is that exiting too early to protect gains severely limits upside potential. This anxiety in locking in profits to avert losses violates the golden trading rules of being patient in trading and prevents traders from catching the big moves and acquiring big profits.
The best way to overcome this bias in Forex trading is to trade with a preset stop loss order. By setting a stop loss order, the irrational decision making driven by loss aversion is taken out of the picture, and the trader will exit a losing trade once the stoploss point has been breached. This removes any blind hope of a rebound, and by squaring off positions, it puts the trader in a neutral frame of mind to enter the next trade, and at the same time frees up the capital for it.
Find out more about trading psychology and learn how forex trading success can be more about your mindset and less about the markets.
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